Gwyneth Paltrow's Investment Newsletter

You may or may not have heard about GOOP, Gwyneth Paltrow's online newsletter designed to -- get this -- nourish the inner aspect.

Basically, it's new age lifestyle stuff.

But even if you're interested in organic yogurt and Feng Shui, you might still want some common sense, hardnosed money news, which is exactly what Gwyneth is here for. She got two of her banker friends to explain how it all works. (via Eddy Elfenbein)

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Basics of Investing

By Rod Rehnborg

Given stories of gigantic "ponzi schemes," bank failures, and obscene Wall St. bonuses, the thought of handing over your hard-earned money to the financial industry is not very appealing. And, as a result, most people I meet wonder what to do with their shriveled, shrinking, nest egg.

Of course, the answers to that all-important question are as numerous as there are nest eggs out there. Nevertheless, it may make sense to "hit the reset button," and reflect on the very basics of investing.

1. Why do we save?

A generation ago, people use to save towards the purchase of a good (TV, car, washing machine, home...) but this changed with the advent of the credit card, the auto loan and second mortgages. Instant gratification was invented and we could pay for the goods AS we enjoyed them, not BEFORE. The birth of consumer loans also meant that there were now only two reasons to save: 1) for a rainy day and 2) for when we grow old and can no longer work but still need to consume.

In other words, the most common reason we save today is to pay for something much later (i.e.: retirement). Thus, the important thing is to have the money we save now grow in such a way that it will match up with the cost of those things we will want to pay for later. There are two things to consider: 1) how much our investment is going to grow and 2) how much the price of the things we will want to pay for in the future will be.

The price something will be in the future depends largely on how much inflation there will be. If our savings do not earn the same percent return as the inflation rate, then we are actually growing poorer even as we save. So the first question we, as savers, should ask ourselves is what the likely future inflation rate will be.

2. Inflation — what causes it?

Basically inflation is determined by how much money is available in the economy. And this amount of money is largely determined by how much people get paid for work and how easy it is to borrow money. Since wages have not gone up much in recent years, and the current job market is terrible, and given how hard it is to borrow money because of the financial crisis, there is not much chance that inflation will increase in the next year or two at least. In fact, the bigger worry right now is DEFLATION.

What's the problem with deflation? The big problem with deflation can be easily understood by looking at a home financed with a mortgage. If you borrowed money for a house and the house drops in value because the cost of everything is dropping, you still owe the same amount of money but the house is worth less. When we enter into deflation, all people want to do is save money to repay debt. Economists call this the "paradox of thrift" in that savings is a "good thing," but if everyone saves at the same time, then it can have negative effects for the overall economy.

So, what is the best way to save for the future in a deflationary environment? That's pretty easy: just leave your money in the bank and watch its purchasing power grow as the prices of everything else fall. A very forward thinking Japanese person in 1990 who was planning to purchase a house in 2009, only needed to leave his or her money in the bank as house prices just hit a twenty-four year low in Japan!